Finding the Correct Moving Average

Written by Adam

When the market establishes a trend in a particular direction, often times this trend may continue higher at a certain angle which simply reflects the strength of the buying forces over a given period of time. What's important to note is that these trends may persist for a great period of time; perhaps several months or years. With that said, we may use a SMA (Simple Moving Average) to define this trend, and use this moving average to plan our future trades.

If we select a moving average too short in time frame such as a 10-SMA, we can see the market may cross below and above, and thus producing a number of false trading signals. On the other hand, if we select a moving average too long in it's time frame, then we run the risk of missing trades as the market may not pull all the way back to this moving average; such as the 30-SMA shown below.

However we can see the market tested and failed to break below its 20-SMA and therefore we may use this moving average to plan our next trade to the long side. In this case, traders may wait for the CADJPY to pull back to the 20-SMA, and fail to 'close' below. Taking this a step further, we may place our protective stops below this moving average at a point where we do not believe the market will trade to.

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